Why the Fed just sent the dollar lower

The dollar dropped against a basket of major currencies on the back of the Federal Reserve's Wednesday policy statement, hitting a nearly one-month low due to a slightly more dovish outlook than expected.

The central bank chose to keep policy as is, leaving the federal funds rate target at rock-bottom levels, and noting in identical language to its April statement that "The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term."

But the Fed also made changes to its projections about both the federal funds rate and GDP, showing that it is now expecting both slower growth and lower policy rates in the near future. To some, this points to a good deal more downside for the greenback.

Jens Nordvig, Nomura's global head of fixed income, recommends exiting long-dollar positions on the back of the Fed news.

Nordvig had previously suggested being long the dollar against the yen, and being long the euro against the dollar (which is equivalent to being long the dollar against the yen).

Referring to the euro trade in a Wednesday afternoon note, Nordvig wrote that "This trade was partly based on the prospect for a 'status quo' view from the Fed, which is not exactly what we have been getting today," due to the GDP and future fed funds rate (or "dot plot") projections.

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Janet Yellen

Kathy Lien, currency strategist at BK Asset Management, wrote that "There's no question that the Fed disappointed FX traders. ... Investors were hoping for a clear road map for liftoff, but she did not even mention that the chance of a September rate hike has strengthened."

Generally, rising rates cause a given currency to climb as well, given that it makes holding that currency more profitable. That is, if risk-free rates in the U.S. become much higher than risk-free rates in Europe, holding dollars is then that much more attractive than holding euros.

Still, Lien says that "In no shape or form do we believe that the long dollar trade is dead. In fact our conviction about the dollar rising was strengthened by Yellen's comments. From the FOMC statement and forecast, we know that the majority of policymakers expect rates to rise this year with a larger number looking for two quarter-point rate hikes in 2015."

Consequently, Lien is on the other side of Nordvig's trade, writing that "We have used that latest pullback as an opportunity to reload some of our long dollar positions."